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The challenge of completing our retirement income system

The Retirement Income Review (Callaghan) Report concluded that the Australian retirement income system is effective, sound and its costs are broadly sustainable.

While the Review’s terms of reference were ‘to establish a fact base’ rather than make recommendations, the Report has a very clear overall message: that we should now focus on settling the pensions phase of the system, moving on from the focus up until now on the accumulation phase. That is a message many of us have been pressing for several years now.

9.5% not enough for vulnerable groups

Should the Government decide not to proceed with the legislated increase in the superannuation guarantee (or at least not the full increase to 12%), citing the Report’s evidence that optimal use of savings accumulated at the current 9.5% can deliver adequate retirement incomes for those on median incomes or below, there must be a quid pro quo. The Government should fix the outstanding problems in the pensions phase that are causing sub-optimal use of savings and leaving gaps for particular vulnerable groups. Unless these problems are resolved and retirees fully utlilise their savings, then as the Report finds, an accumulation rate of 9.5% will not deliver adequate retirement incomes.

Unfortunately, Callaghan is not very helpful about the solutions to these problems. The Report highlights the underlying problem of complexity and suggests the need for much greater cohesion particularly between superannuation and the age pension, but it offers no support for any of the practical solutions it canvasses. Strangely, it also questions the value of the measures available to directly increase support for those facing the greatest financial stress without offering alternatives.

Difficult optimal drawdown solutions

The Report’s ‘optimal’ use of superannuation is questionable. It is doubtful that funds could offer the drawdown arrangements it involves: these are highly complex as they are designed to reduce real superannuation incomes as people get older to offset exactly real increases in the age pension, with superannuation balances dropping to zero at age 92.

The optimal use also assumes that 5% of the savings will be directed into a deferred lifetime annuity from age 92. But the market for life annuities is already struggling and the likelihood of funds being able to offer an annuity that does not start to be paid until 25 or more years into the future seems extremely unlikely. This ‘optimal’ arrangement would also still leave unused some of the accumulated savings whenever the person died before age 92.

Much more likely models for sensible use of superannuation, consistent with the objectives of the system, would include life annuities from retirement (requiring most of the savings) with the remainder available for spending in the first decade or so for holidays and other active retirement living consumption; a small amount might be retained as insurance against unforeseen events but, as Callaghan rightly says, there is significant public insurance for health and aged care.

Such models would of course need to vary depending on the person’s accumulated savings and the extent to which they should sensibly rely on the age pension, including for managing longevity risk. But for most people, the simplicity and security involved in having some form of life annuity starting at retirement should be most attractive. And if the funds claim they cannot offer life annuities, the Government should step in and sell them.

The Report’s emphasis on avoiding any real increase in total retirement income (super plus age pension) while acknowledging that the pension itself should increase in line with community incomes, would also cause some anomalies. As people age, retirement incomes at lower income deciles would become increasingly compressed. The more likely models involving CPI-indexed life annuities would, setting aside the funds kept for early consumption, lead to a pattern of regular income growth somewhere between wage indexation (for those reliant solely on the pension) and CPI indexation for those not reliant on the pension at all. Such a gradation would avoid the anomaly the Report’s ‘optimal’ model would cause.

Struggling to define income in retirement

While following the 2014 Financial System Inquiry the Government has lent support to requiring funds to offer ‘Comprehensive Income Products for Retirement’ (CIPRs), it is now high time to advance that agenda and to clarify what the CIPRs should look like. It is disappointing, however, that the Callaghan Report fails to provide useful guidance in this regard, especially as the progress in introducing CIPRs has been very slow and without them the Report’s key conclusion does not stand up.

Further work is also still needed to confirm or otherwise that key conclusion that appropriate use of superannuation savings would lead to adequate retirement incomes for those on median income at the current 9.5% superannuation guarantee.

Despite my previous advocacy for the SG to increase to 12%, my suspicion now is that Callaghan’s conclusion will not be far out. Of course, those on higher incomes need to supplement the SG with voluntary savings. The Report mentions the FitzGerald finding in 1993 that, in the absence of the age pension, people would need to save around 18% for an adequate retirement income, a rate not dissimilar to the 20% OECD average contribution rate (or the rates applying in most existing Commonwealth Government schemes (including employee contributions)).

Even with the high drawdowns the Report uses, the marginal increase in net retirement incomes from marginal additions in savings are very low. This suggests that, at the margin, the trade-off between incomes during working life (reduced by such extra savings) and incomes in retirement (very slightly increased at best) is extremely poor, and certainly not justified when the extra savings are compulsory. It is concern about just such trade-offs that the Report elsewhere emphasises when questioning the need to increase the SG.

While concluding that the level of the pension is sufficient to protect people from poverty if they own their own homes, the Report highlights the extent of financial stress faced by retirees in private rental accommodation and those involuntarily retired before age pension age. But the Report does not lend support to the most obvious measures to reduce this stress.

Housing inequity

The Report rightly draws attention to the inequities involved in treating assets held in the home differently to other assets. There is little doubt that, in principle, the value of the home should be taken into account in the means test (and also treated more equally with other savings in the tax system). But home ownership is rightly seen as one of the pillars of the retirement incomes system, providing both security and income-in-kind. With home ownership, the age pension ensures adequate protection from poverty.

The difficulties with including the home in the means test go well beyond the obvious political ones given over 100 years of exemption. Apart from identifying an appropriate threshold (or thresholds based on location), it would be essential to ensure easy access to an income stream funded by the home assets for those left with insufficient age pension support.

The current Pension Loans Scheme goes a little way towards helping people draw on their home assets to supplement their age pension, but there would be considerable advantage if many more home-owners had access to income streams financed from their home assets, particularly amongst the current cohorts of retirees who do not have substantial superannuation savings. This would enhance the retirement incomes system whether or not action was taken to include the home in the means test. It should not be difficult to design market-based schemes with appropriate consumer protection to guarantee occupancy and to limit the net reduction in the person’s home equity. If the market has difficulty offering such products, however, there is a strong case for the Government to extend the existing scheme, based on repayment from the eventual estate.

A step towards more equitable treatment of renters vis-à-vis home-owners would be to increase the gap between the assets test threshold for renters above that for home-owners.

Taxation of superannuation

The Report highlights its assessment of the cost of tax concessions for superannuation and that they are concentrated on those with higher incomes. The Report argues that the concessions should be benchmarked against ‘what is’ rather than ‘what should be’, where ‘what is’ refers to the existing ‘comprehensive income’ tax treatment of other savings i.e. taxing both contributions and earnings at the individual’s marginal rate of tax but exempting any tax on final spending (or TTE). Some account is taken of the likelihood of changed savings behaviour under such a tax regime, but this is assumed to be small as the superannuation savings are mostly compulsory.

The Report’s figures highlight the ‘concession’ on how earnings are taxed in particular, revealing that those on the highest incomes and who are the oldest (and hence have held their superannuation savings the longest) are gaining the most ‘concessions’. In terms of any reasonable counterfactual, that is misleading.

Moreover, it plays into the hands of those interest groups who believe there is a magic pudding of tax revenues available for redirection from the wealthy to their particular priorities.

The case for an EET regime for superannuation is actually very strong. Pension schemes overseas generally take this approach as we still do in Australia in the case of the old public sector benefits promise schemes. This is not just because most overseas schemes have no identifiable contributions (or earnings) that could be taxed but also because they are generally compulsory and cannot be accessed before retirement: they do not provide any taxable capacity when they are accumulating. Moreover, the savings are very long-term, generally around 40 years.

Perhaps, as Callaghan seems to be pushing, the tax on earnings could be extended to superannuation held in the pensions phase, but the Report’s view that 15% represents a ‘concession’ (and really should be increased) is inappropriate. If anything, I suspect the tax on earnings should be lower – perhaps a revenue neutral move to around 10% should be phased in for both the accumulation and pension phases. (A recent report by the Tax and Transfer Policy Institute suggests that, if all forms of savings were from after-tax income, a flat tax of under 10% on the earnings would be revenue-neutral, progressive and efficiency-enhancing.)

An agenda to complete the Retirement Income System

Most likely, the Callaghan Report is correct that the SG does not need to increase to 12%. Further work might confirm this (and whether 9.5% is sufficient or moving to 10% is still advisable).

But the Report also demonstrates the need now to settle the pensions phase of our retirement income system. Foregoing the full increase in the SG to 12% (and the costs to revenue involved) requires a quid pro quo that does precisely this if we are to ensure an adequate retirement income for most retirees. This quid pro quo should include:

  • Funds to report regularly to members on the income streams in retirement their superannuation savings are likely to lead to;
  • Accelerating the move to require funds to offer CIPRs that guide people to optimal use of superannuation which, with any age pension entitlement, delivers adequate and secure retirement incomes (if necessary, involving the Government selling indexed annuities);
  • A simplified age pension means test that ensures higher savings do in fact lead to improved net retirement incomes while still concentrating assistance on those most in need;
  • A sizeable increase in rental assistance, towards that available to public housing tenants, and a sizeable increase in Jobseeker, particularly for the over 60s;
  • The introduction of a broader home equity release program with repayment from estates, if necessary managed by the Government.

Some of these measures need further development but the work required is not particularly complex nor are the financial and political hurdles involved excessive. Indeed, the final outcome would confirm the quality and effectiveness of the emerging Australian retirement income system and its deservedly high international standing.


Andrew Podger, AO is a retired Australian senior public servant. He is currently Professor of Public Policy at the Australian National University (ANU). This article was originally published on the website of the Tax and Transfers Policy Institute at the ANU.


Lyle Essery
February 13, 2021

The current tax concessions in accumulation phase super accounts for earnings, contributions and capital gains should be increased to company rates (30%) + Medicare levy for accounts that already are of a size that would exceed the pension phase cap ($1.6 million ). -member has already achieved their retirement fund saving goals son does need tax concessions any more.
Furthermore, accumulation accounts of members who already have taxfree retirement phase accounts should be taxed as per above to regardless of their balance. Because as the member has already retired, they not need concessional taxation for them to save for retirement .

February 13, 2021

Agree entirely. This is a major and obvious flaw in the system. So much so one has to conclude it is deliberate.

However, from personal experience, it is not beyond realm of possibility to have accumulation account though the pension account maximum has not been met. If the pension account has been maxxed out, the returns and CGs of the accumulation account(s) should be taxed as would be if held outside super. To put it in a way easier to comprehend perhaps; once the pension account reaches its maximum, all accumulation accounts should not be regarded as superannuation for tax purposes and taxed as held outside super as part of income tax returns.

February 12, 2021

First and Foremost : "Andrew Podger, AO is a retired Australian senior public servant. He is currently Professor of Public Policy at the Australian National University (ANU). This article was originally published on the website of the Tax and Transfers Policy Institute at the ANU."
"The federal government's recent decision to postpone drawing from the Future Fund to help finance its unfunded employee superannuation liabilities is welcome news for current and future members of its defined benefit funds."
"The Future Fund is an independently managed sovereign wealth fund established in 2006 to strengthen the Australian Government's long-term financial position. At 31 December 2019, it was valued at A$168 billion."
Personally , he has no worries about superannuation or an old-age-pension because he is covered by a "separate scheme"
which covers and GUARANTEES retired public servants , the so-called Future Fund , so his experience of "real life" is somewhat limited , because Professors are pretty-well paid as well. Their "pensions" are "bullet-proof" and paid for by that special Future Fund. Quite unlike the rest of us , although it was our tax has built that fund , but can't share in it !
This lack of exposure to the realities of SMSF retirees and old-age-pensioners should EXCLUDE him from comments or
any involvement in determining how anyone-else's pension or retirement income is constructed or decided .
And yes , it really annoys me that someone from a protected and privileged position and , therefore , so unsuitable , is chosen to pontificate on any aspects of OUR retirement funding !
Only someone from the "real world" , with a grip on the sacrifices and scrimping and saving that is necessary , should have
that sort of input.

February 11, 2021

Home ownership 'inequity': Many age pensioners live in modest homes with low income relatives. After being forced to draw on their own home to fund a pension, after their deaths the home must be sold as it can't be fully inherited by the low income relatives. Are these people to be tossed out of the family home onto the street after the deaths?

February 11, 2021

….. models for sensible use of superannuation, consistent with the objectives of the system, would include life annuities from retirement…

An annuity is like a life insurance policy in reverse. You hand over a lump of capital and in return the insurer guarantees you an income stream for as long as you live, usually indexed to inflation, and regardless of stock market gyrations. For retirees, annuities eliminate market risk, inflation risk and most of all, longevity risk and therefore eliminate most of the uncertainty people face in retirement.

From a policy/academic point of view, annuities have the added attraction of pooling risk. Because generally there is no residual capital remaining on death, it means that the people who die at an earlier age than the rest of their cohort effectively subsidise those who die later and therefore the cohort as a whole is less dependent on the taxpayer.

For me as an individual, an annuity is essentially a bet with the insurance company on my life expectancy. As I don’t know when I’m going to die, I have to accept the possibility that I will be in the group who will die early, and any unused money I spent on my annuity will be used to pay the guaranteed income of those in my cohort who will live much longer than I. While there is a risk that might happen, there is no way I would buy an annuity, because I would rather give my unused assets on death to my children than to other members of my cohort. An annuity represents significant risk that I am not prepared to take.

If I am going to die well into my old age, after my own resources are exhausted, I would be quite happy for others to subsidise my lifestyle, but that already happens. Both the Retirement Income Review and this article highlight how good the age pension is as a universal safety net because it also includes the government insurance around health and age care.

As usual, policy makers and academics understand the problem of retirement risk in theoretical macro terms of a cohort, its size and median life expectancy but they fail to understand the individual rational response to uncertainty and risk. It also explains their puzzlement over the lack of popularity of annuities in the wider community.

February 10, 2021

This report totally lost me in a welter of abbreviations that may have been clear to professionals who are intimately involved in the topic, but completely obscured the meaning to anybody else. This may be the most erudite article ever written on the subject of retirement income, but it means little to me.

Jeff Oughton
February 06, 2021

Agree - the lifetime home loan and related annuity "market" - both the govt and shadow bank providers and the buyers (elderly Australians) - does have difficulties.
First, the government loan rate @ 4.5% may be lower than shadow bank rates - but it's unattractive and unfair relative to the small over collateralised AAA rated low credit risk lifetime home loans and the government's own borrowing and operating costs. Frequently, it's a last resort lend to access illiquid savings by an income constrained elderly Australian! Secondly, many potential borrowers need self-interested advice to understand this package of lifetime loan and income stream to overcome their biases and the uncertainty faced.Thirdly, the current govt product package is limited; no scope for lump sums etc etc . I also suspect that many asset rich elderly Australians are simply unaware of the retirement lifestyle package available at Centrelink/Services Australia or have biases against going back into debt by unlocking their private savings in their home.

So the "market" place - price, promotion, product and place - all are failing - and both the govt and shadow bank retirement income solution is falling well short of the potential to boost the incomes and well being of many elderly Australians. Both govt and shadow banks appear happy to make super profits on a small part of the potential opportunity. And many elderly Australians remain asset rich....over saving during retirement.

The market is falling to lower the price/loan rate, add features to the product (eg capital release etc), promote the product/package/lifestyle to elderly Australians and provide (self interested/best) advice

February 05, 2021

"The challenge of completing Australia’s retirement [phase] income system": Once completed, then move on to 'Australia's dying phase income system'. Age care costs lots. Generally a house worth of capital per dyee plus an age pension worth of income. The all phases, from hatches to dispatches, will be in purview.

February 05, 2021

"the simplicity and security involved in having some form of life annuity starting at retirement should be most attractive. And if the funds claim they cannot offer life annuities, the Government should step in and sell them."

That would be the Age Pension for ALL age eligible - including those whose taxes paid for ALL the welfare.


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